Immediately after the Fed announced its 50 bps interest rate cut, Vincent Deluard, Director of Global Macro at StoneX, joined Maggie Lake for a live broadcast to discuss its impact on financial markets and the economy. If you missed Wealthion’s special broadcast, now is the time to catch up on Vincent’s expert insights and learn what this rate cut by the Fed means for investors.
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Maggie Lake 0:00
Hi everyone. Welcome to wealthions, live coverage of the Federal Reserve meeting decision. I’m Maggie Lake, and with me today is Vincent Delaware, Director of global macro strategy at Stone X. Hi, Vincent, it’s great to see you.
Vincent Deluard 0:16
Hey, Maggie, great to see you. Happy. Father to you, exactly. Okay,
Maggie Lake 0:19
so we gave everybody a second to digest the news that came out. If you were multitasking you didn’t see it, the Federal Reserve cut interest rates by half a percentage point. And Vincent, we should say that it was very divided. Going into this the market split really on whether they would do 25 or 50. And a really robust argument around that. What do you make of the initial top line decision?
Vincent Deluard 0:42
Well, I expected 25 so I will just be honest about it, I got it wrong. I mean, I think that the Fed had, you know, send these balloons right with, you know, Wall Street Journal articles and try to get that that 50 back in the curve. And, yeah, apparently, that’s what they wanted to do. I would personally think that the CPI data, the jobs number or the PPI certainly did not justify a 50 piece from move. But I guess we’ll have to see what they said the press conference to explain why they choose to do that.
Maggie Lake 1:16
Yeah, so And just so everyone knows the cadence here, the decision came out. The initial details are out, but but a lot is going to hinge on what Jay Powell says in that press conference. They’re going to give a lot of color behind why they decided to be more aggressive and important here to point out Vincent, you were not alone when we say the market was split. It was, but a lot of the split came between economists and strategists such as yourself, who really look at the data, who really pay attention to what’s happening in the economy and with inflation and all the factors the Fed looks at, who kind of thought looking at it, maybe 25 was the right move, and probably what the Fed would do, they tend to be a bit more cautious when they start a New cycle. And this is a change from hiking interest rates, right? This is the pivot that we all talk about. And then the market, which had run away with some of those sort of rumors and, you know, breadcrumbs in the Wall Street Journal, not other places, and also just the market wanting to see something aggressive. So the market was pricing in 50. A lot of economists said, Hang on a second. That’s too much. So that’s where we we got that split in disagreement. That’s why this press conference is likely to be so important. And if we look at the market reaction, it’s, you know, the Fed’s going to be watching this too. We saw an initial rally across the board for us, stocks, NASDAQ, leading the way, risk assets. But, you know, talk to me about that reaction function, because if the market starts rallying, this is not necessarily a good thing for the Fed, or is it. How do you think they’re going to react to that? What do you make of the gains?
Vincent Deluard 2:54
Well, I mean, I mean, I, first of all, I think the Fed is just going to ignore that and say, Oh, we don’t care. We, you know, we pretend not to look at any of that, and you know that that’s going to be their boilerplate language in general. Like, I think the market rallying is bad news, because that that means that you see an easier transmission, unless you think the economy is within the doldrums, and we need to, like, really throw everything we have at it, which maybe what power is going to say? I mean, I don’t see it, but maybe, if this is just an adjustment cut, and if you know the inflationary ambers, as I believe, are not completely dark yet, you’re just adding fuel to the fire here. I mean, you you’re increasing the value of assets. You’re easing monetary financial conditions, which are already very easy, and I think that increases the risk that, you know, two months down the line, we have a pivot from the pivot,
Maggie Lake 3:49
yeah, which is why I asked you if they’d be looking at that, and especially, gonna be important to see whether it was a unanimous decision,
Vincent Deluard 3:55
because it wasn’t. I think there was one decent idea, one Disney,
Maggie Lake 3:59
okay, yeah. Yeah. These are all the headlines coming in while we’re on talking. So does this tell us? So when the Fed does something aggressive like this, we often think, do they know something we don’t do? Should we think that perhaps the Fed is worried about something in the system, or is growth slowing, slowing to the degree is a recession knocking at the door that the Fed would be worried enough to go 50. Is that how we should read this?
Vincent Deluard 4:30
I mean, I would read it as the Fed is worried that it, you know, should have cut in in July, didn’t do it, and now it’s trying to make up the lost ground, and so that they don’t look too bad. I think the recession is, I mean, where, you know, you look at the kind of fed GDP, now it’s at 3% housing stalls are really good today. Unemployment rate ticked down the last report, hours work increased. I would have. Many questions for for Jay Powell, if I were in that room, like, what does he see? That makes him think that we need, you know, 50 basis. I mean, we could very well have gone, you know, 25 and increase the speed, if need be. But it seems like you know why front loaded so much. Yeah,
Maggie Lake 5:16
so you don’t, do you think that that does that there’s very important to dig beneath some of the narratives here, right? And so do you think that the economy is slowing enough to face a recession? If not, why not? What are the things that you see that indicate the Fed should be a little bit more conservative here?
Vincent Deluard 5:36
Well, so in general, I think we have this massive issue with statistics. It started before covid, but also with quality of statistics. And we’ve seen that all these revisions, all these adjustments, very low response rate. So since that happened, I spent a lot more time looking at the day treasury statement, which measures the cash coming in and out of the Treasury account, and specifically looking at tax collections, because I believe this is because I believe this is, you know, tax collection. Everybody pays taxes. We all hate to do so, so no one pays more than they should, and we can see that on a daily basis. At this point for the year, tax collections are up 9% from last year, and there hasn’t been a change in tax law. So I don’t think there’s been any case in history where you’ve had people pay 9% more in taxes and the economy falling into recession quite immediately. And if we look at the more recent trend, and of course, it’s some volatility, right? I mean, some some of the tax collection, you know, you get more money at the end of the month, beginning whatever, adjusting for that, there is no sign of a slowdown. So that’s what gives me confidence that the economy is not slowing. And then again, because there is so much uncertainty about the feds, the BLS release, I look at anecdotal stuff, because at the end of the day, I mean, the world is just, you know, a lot of anecdotes tied together. You look at TSA crossing, you know, how many people are flying across the country, record high, 10% higher than last year. You look at restaurant bookings, you look at Red Book index of retail sales, you look at concert attendance, all these kind of anecdotal stuff points to an economy that’s that’s doing just fine. So I legitimately do not know what the Fed is seeing, other than this massive pressure, you know, basically the market’s been, in my opinion, almost bullying the fed into carrying by 50 and, you know, contrary to prior instances, what happened, the Fed seems to have, you know, given it. Yeah.
Maggie Lake 7:36
So if we look at, and I want to dig into a little bit more about sort of, you know, what people should be thinking about when it comes to this, and maybe some of the sort of narratives to challenge that we hear out there. But when we look at the reaction, stocks are rallying so if there’s no recession and the Fed’s now, you know, lowered interest rates, positive for risk assets, positive for us, equities, yeah,
Vincent Deluard 8:02
of course. I mean, buy, DJs, buy, you know, the
Maggie Lake 8:08
DJ degenerating everybody.
Vincent Deluard 8:10
We have 3% inflation. And, you know, 6% nominal, 3% of real growth, and the Fed is cutting by 50. I mean, of course, buy, buy everything, guys, it’s the Fed put, but with a strike price that’s like, way above anything that made sense before. And I would also look at gold. I mean, gold, you know, yeah, gold is at, what, 2600 on the day. Yeah, it’s almost got 2600 Yeah. But yeah, we have a, you know, fed cutting by by 50 bips when the market is an all time high and, you know, the non profit rate is basically 50 Euro low, and inflation is one and a half percent above targets. So, yeah, I would definitely be a buyer of anything that represents a real claim against the economy, because this is very positive for nominal growth, I
Maggie Lake 9:01
would guess so. Because, you know, there are people who are looking who’ve been we’ve been coming into this thinking we saw the wobbles now. We’re sitting near record highs again for equities, but we saw those wobbles in the summer. There’s been so much talk about the AI bubble bursting and people needing to get more conservative. There’s so much volatility. We’re, you know, seasonally in a tough time for markets, but this seems like it just opened the gates for the bull.
Vincent Deluard 9:29
I mean, there’s only 12 days left in September, right? So better, better get that bear market going soon.
Maggie Lake 9:37
Well, with this as a backdrop, it doesn’t seem like it. So okay, maybe for those who were worried about their equity position, this is, this is good news. What about if that? If it is the case, we’re looking at Treasury, yields look like they’re rising a little bit. What does that mean for bonds? If it’s good for stocks, is it? Is it bad for bonds? Yeah? Um,
Vincent Deluard 10:02
I mean, I think it argues for, you know, steeper curves, right? I mean, you’re going to cut, you’re going to get the short end more than people thought. And then I think the long end needs to start pricing this kind of hyper reactive fed and the risk that, you know, growth and especially inflation, increase. So, if you were to think like, you know, the cats were going to come later, and then you kind of front load them, it makes sense for the curve to be steeper, and, yes, along and to the long rates to increase on the on the day. I mean, is that what has been going on today?
Maggie Lake 10:38
It looks like, you know, listen, we’re all getting this like that. You look on, look on your I’m looking on my Bloomberg right now, yeah, because where are we? Things are going to move quickly. So it
Vincent Deluard 10:49
fell, it fell on the news, and then bounced back. Now it’s still like 3.6 I mean, which is still, you know, if you think about an insanely low level for the for the 10 year one, again, you have real GDP growth of 3% for four quarters now, inflation still, you know, some segments of inflation re accelerating if you get shelter, if you get core services, and you have very easy fed and the chance that fiscal policy becomes even more commodity after The after the election, yeah. I mean, I would be max bearish on duration at this point.
Maggie Lake 11:25
So we’ve got some interesting, interesting comments, and I just want to look through them, because I think this is going to be the concern. Chris saying this huge cut emphasizes just how disastrous the US economy really is. It’s a question is, with this move, is it going to increase higher inflation? There’s a, there’s a tension here, isn’t isn’t there Vincent so let me just break that apart. Is the US economy disaster? It sounds like you’re saying no, and I teased out today. You said the Fed more attention to hairdressers. What do you mean by that? We got, we got to talk about this, because you always think outside the box. What do you mean by that?
Vincent Deluard 12:01
I mean, every CPR report, the first loan I go to is haircuts. And the reason why I love haircuts is not, not because, not because you have good hair. Yeah, no, it’s not that great. I do super cats, you know, by the way, but the inflation, that’s how the whole story I was watching super cut. You know, you could get your hair cut, like 10 bucks, and that was, like 30 with tip. I mean, it’s kind of a, you know, in a couple of years. So this is your real economy indicator, yes, yes. And I think that’s interesting, because, you know, haircuts, you know, we live in world of change and disruption and deep fakes and everything. And haircuts is wonderful, right? I mean, the technology is, you know, hands and a pair of scissors, the time it takes to get hair about the same as you did 100 years ago. There is no supply chain, there is no Russia, there is no shenanigans, there is no OPEC, there is no AI, there is no semiconductor. All you get in a haircut, effectively, is okay, I’m going to hire someone who hasn’t gone to college to work on my head for about 20 minutes, rent a small space, pay utds and pay insurance. So if you think about what goes into core inflation, core service inflation, it’s really wonderful. Another thing I like about haircut is probably the last sector in the US economy where there’s no cartel, private equity owned cartel that kind of manipulate the price? No, it is the only, maybe the only, point in the economy that actually approximates what economists think about when they think about the economy with a model, you
Maggie Lake 13:30
know, pure, clean read, it’s a clean activity,
Vincent Deluard 13:33
and it works. So for the past decade, we had, you know, the price of a haircut rose by 1.8% from 2010 to covid, which is exactly what happened to the overall CPI. So over time, it makes sense, because if you think about what inflation is at the end of the day, it’s the cost of labor. Everything we consume is transformed labor one way or another, right? So it works, and since covid, it reset to that four to 5% plateau. Now whenever went to 9% because the jump to 9% obviously, was things like use cars or plane tickets, things that were impacted by the reopening and covid and shocks to the supply chain. So it just went to four, five. And this has been bouncing around there, and lately, I mean, I don’t want to make too much of a read on this, but in the past two months, actually accelerated to about six 7% and you see that most clearly with haircuts, but you see that also if you look at laundry, dry cleaning, childcare, nursing home, anything that’s kind of labor intensive, you’ve seen that reset from 2% before covid to four 5% which makes me think that we live in a four, 5% inflation world. We just, you know, we just have a lot of noise coming from, obviously, all prices have been jumping a lot already. Prices have been jumping a lot. And also core goods, right, which is a part of the CPI that usually is kind of boring, but because we had all these supply chain issues, you know, they went up a lot. And as the supply chain issue cleared up, you know, they came. Down a lot, so that that actually some noise, which is why I think the noisier the data, the more you want to focus on on things like haircuts. Yeah,
Maggie Lake 15:08
I absolutely love that. It’s It’s so fantastic. And you’re right. We’re all trying to figure out how to sort of make sense of these economic readings that seem like they’re a little harder to understand. So some other folks in the chat are talking about, is there a risk of hyperinflation? So I know you’ve been concerned about inflation, and in your report, you talk about some things that you see as an indication that we haven’t tamed inflation. Because if the Fed’s cutting 50, they’re basically saying, like, we won the fight against inflation, right? But not so fast. Is that a risk that we could see a return to inflation? Maybe not hyperinflation,
Vincent Deluard 15:49
you know? So there’s, I recommend you guys. Steve hunker, I think, is the economist that’s a specialist, and he has this amazing table of case of hybrid. So he has this Hyperinflation is something that has a clear definition, if I think it’s a monthly rate, it’s a monthly rate of inflation of about 50% for more than 28 days. So we’re talking like, you know, I’m not even sure that Venezuela qualifies here. Yeah, this is an extreme. We’re talking like, you know, Zimbabwe or Weimar Republic or Hungary in 19 so I am
Maggie Lake 16:19
not forecasting, to be clear.
Vincent Deluard 16:22
I mean, you know, price
Maggie Lake 16:24
are comfortable saying that you’re a bit of an inflationista? Yes, yes, no.
Vincent Deluard 16:28
What I see happening is a reset of inflation to, you know, four by and I would argue we already there. That was the point of Mario haircuts. You know, it’s been four years now that we’ve had, you know, hairdressers making four or five or at least, I don’t know the hairdressers are making more, but certainly the customer haircut has been going up for for four and a half 5% for four years. Now, if you look at more services, we already live in that world. I mean, the last sub 2% print was, what, February of 2021,
Maggie Lake 16:57
and that’s services. And when you talk about services, and this is why the haircutters are great. We’re having some fun with it, but, but it is a really important because a lot of our economy is based on services. And yes, totally all of us know that if you’ve gone out to eat, if you’ve tried to travel, all of the things that we do fall into the services category. And so while manufacturing has been weak, and you and many others have pointed this out, we have sort of dual economy services have held up and been strong. You’re also looking at shelter, which is important in CPI we use you had a chart I think we can pull up in in your research. Why is that something we need to be paying attention to? And you’re going to hear, you know, Owner, equivalent, rent, all these sort of fancy terms. But why does shelter matter? And what are you seeing there that worries you when it comes to inflation? I
Vincent Deluard 17:43
mean, the waste, right? I mean, it’s a 30% item in the CPI shelter. So, you know, if you’re significantly above 2% on shelter, you know, it’s going to be very hard to make that up with all the categories, especially when you pour services at shelter at 445, percent, right? So you need intense deflation in goods and commodity prices to make up for that. Now shelter is important, because shelter was the crux of the argument of the deflationist recession is was that the way the Fed measures shelter costs for the BLS and then feeds into the Fed is lagged, right? They have this survey where you ask people, How much do you think you would rent your house for, and then the panel of rents that they use rolls over slowly, so you’re lagging. And the idea was that the Fed started hiking two years ago. We had a falling. Actually, we don’t, didn’t really have a falling, right? This inflation in rent. So that’s going to feed through the data, and we’re going to see lower shelter prints. So we need to look at inflation X shelter. And if you did that for a couple of months, you could see that we were below 2% we were below 2% at shelter. Now this relied on the premise that shelter was going to drop from that plateau of four or 5% had been stuck at for many years now to something like 2% and we saw that in June. For one month, shelter was at 2.1 or 2.2% annualized basis. But for the past month, July and August, we bounced back up, and now above that plateau of 5% My view is that June was the odd month that was the problem, because if you look at at the end of the day, how do you set up the cost of a rent, right? You have, like, basically three items with one is the cost of the building. Now, what do we know about real estate prices? I mean, education is an all time high. You know, in all the 20 cities that go in the case Sheetal, you have gains of more than 2% for the past year. I think on average, about six to 7% so the price of the building is going up. Second bucket is, how much does it cost to maintain the building? How much do you have to pay for maintenance, for electricity, for insurance, for garbage collection, things of that nature, that’s going up. We’re going back to the service story, right? You know the cost of the hairdresser, basically, this is the same. The cost of the maintenance guys going up by 5% so the cost of maintaining the building is going about 5% But the cost of the building itself is going up by 5% now, the third item is the margin, right? I mean, how much does the landlord take? Landlords typically are not charities, especially now that we have, you know, private equity owned real estate market, so I don’t see how you can sustainably have shelter even three 4% with that. So if shelter, which is a 30% weight on the CPI, stays at four 5% and core services is reset to four 5% I mean, that’s more than 50% of the CPI at that four or 5% level, sure you can be lucky. And to some extent, we are lucky, right? We have these very weak energy prices. We have this record on production that’s helping. We still have a lot. We import our deflation from China. We had a strong dollar, so we had all these kind of temporary thing that really took it down and gives the Fed, indeed, some space to maybe cut. But we have not solved the problem. So I would stay at obviously not hyperinflation, but a reset to an inflation rate of four or 5% seems, I mean, it’s what has happened we just yet, which
Maggie Lake 21:09
is, which is, again important, because we’re talking about this on a day when the Federal Reserve just cut interest rates a half a percentage point. That’s a lot. That’s, by
Vincent Deluard 21:17
the way, remember that that they were at zero. They waited until 8% doing and I think they raised by 25 right? The first, I think in March of 2022 I’d have to check, yeah, if you look at the asymmetry in that reaction function, yeah, right. I mean, when you have high inflation, they wait for you to be 8% Yeah, the target,
Maggie Lake 21:38
to be really sure. But now on the way down, right now,
Vincent Deluard 21:42
we have, we had one good CPI. June was good. Last month was not good. It was not bad, but it’s not good. So
Maggie Lake 21:50
I’m sure we’re going to get people and again, we’re about five minutes away from the press conference, but we’re going to continue to talk a little bit. I’m sure going to have people say, well, there are people talking about and there have been, right? There have been not only politicians. We know that some of the politicians have been clamoring for an aggressive rate cut, but we know that’s economist, some strategy
Vincent Deluard 22:10
Warren, right? I mean, she does that every month. Yeah, it’s
Maggie Lake 22:13
a regular if you But economists, and some of them are saying, well, look at true inflation, true reading. Why? Why do you do you not look at that? Why do you think that that’s not an accurate read? So trueflation.
Vincent Deluard 22:25
I mean, there are, it’s not the same measure. I mean, just if you get shelter, for example, I know shelter in two, 18% versus 30. And there are other differences like that. True I think because of the nature, they aggregated a lot of prices over the internet. I think they’re somewhat, maybe more exposed to this kind of imported good deflation. Okay.
Maggie Lake 22:48
So, yeah, okay. So, so, you know, this is why you can kind of, you can’t pick narratives. You have to have a framework, because you can find some statistics that support your point of view if you want. So you have to really work to dig in. I want to, I want to switch to bonds, because there are a lot of people who might be listening to this, who you know came to age have been, always been advised about diversifying their portfolio. We talked a lot about 6040, whether that made sense, it seemed like more recently it was back, or people were, you know, talking about bonds. I tweeted the other day, if you follow me, that I read a headline saying one of blackrock’s main people said, you know, with the rate cut, is going to usher in a golden age for fixed income. And I found that interesting. Was he a bond fund manager? Maybe, yeah. Were they bond fight bond fund? Were they talking their book. You’re asking Vincent, very good question, but I think it’s really important, because people are trying to figure out, right now, I’m worried about a bubble. Have the best gains? Are they in inequity? Should I be more exposed to bonds? This is why we’re spending so much time talking about inflation. If we’re in a higher inflation environment, Vincent, what does that mean for bonds?
Vincent Deluard 24:00
Well, so obviously, I mean, inflation is a great bond killer, right? So you can have this debate about whether inflation is good or bad for stocks, and you have mixed evidence, I would argue that it’s primarily good, especially the Fed doesn’t fight it, because at the end of the day, stocks are a real claim, right? I mean claim on real assets you own whatever, minus the debt you own the company, minus the debt you own the fixed asset, and then you own a claim on the future cash flows. And this cash flow will grow at the pace of nominal growth. That’s not the case with bonds. So I would argue that on balance, obviously inflation is beneficial for stocks and negative for bonds. Now it can be negative for stocks in the 70s, when the Fed fights it right, that’s when it becomes a stock. Like in the 70s, famously, we had these two 50% plus bear markets and equities on a real on a real basis, not probably around 75% of the value in decade, because the fed funds, the Fed Funds were going to 18% right when? Volca really went crazy to state invasion dragon. Now, if you have a fed that is not doing anything, yes, oil and SQL is bullish for stocks. And I know it hurts to say that, because you feel that stocks are expensive and you get this AI bubble and blah, blah, blah, but we live in a you know you have to compare like you have to do something of your money. So what did the Fed do today? It told you that that money market fund that used to pay you 525, now it’s paying you 475, and that’s going to keep dropping. So I, I thought cash was attractive. Cash is becoming, relatively speaking, less attractive. Uh, bonds are were not attractive at at 3.5% on the tenure. I mean, think about it like, okay, so 3.5 that’s what you get with a 10 year bond. 3.5% that’s it. You would not get anything more that, you know, the coop, that’s that’s what you’re going to get over 10 years with stocks. Yes, I agree. It’s probably the multiple is around 22 right? So take the inverter that that’s about a 4.5% earnings yield. That earnings yields growing at the pace of nominal growth. Now, I don’t expect a recession. I think inflation is going to stay strong. So let’s say that grows by, you know, 3% inflation, 2% growth, you get 4.5% growing at 5% on one end, for tenure or for infinity, and on the other end, with the with the 10 year treasury, you get 3.5% so if anything, yes, it’s painful to do. You know, from CFA, whatever you don’t don’t want to, we can all see the signs of a bubble. But what are you going to do? I mean, maybe you can make a case that you can find cheaper stocks outside the US. I would buy that. Maybe you say, hey, so you want to have some cash. But when it comes to bonds, not just treasuries, but even, even if you could get junk bond, that another, that’s another part of the narrative. That really shocks me is, okay, we’re going to have this recession, right? Okay, it’s terrible. The Fed needs to get by what? What’s the spreading junk bond right now, probably 3.5% I mean, it’s in the top, bottom 5% of the level of spreads. So again, what you have to look at, what pays you. What are your options? I mean, is it duration? Duration doesn’t pay you? Is it quite risk? Credit Risk doesn’t pay you. So yeah, your equity risk premium is actually looking quite good.
Maggie Lake 27:10
So a couple of important questions the that I want to ask you. And as I’m looking at this, stocks are bouncing around. And we expected this to happen because there was a lot of decision they’re up, but they sort of rallied a lot, and then they sort of came back and they rallied because they’re trying to work through a lot of the tensions that Vincent’s talking about. If it’s positive for stocks, do you expect, or would history dictate that it goes to once again, the risk assets tech, mega cap tech is that area and is Does that happen once again at the expense of some value stocks?
Vincent Deluard 27:49
Well, I mean rotation, could
Maggie Lake 27:51
it look different this time if it’s equities?
Vincent Deluard 27:55
I think we’ve tried way too hard to placate narratives on on, on, tech and the relation between tech and interest rate, it’s a complex one. Um, if you go by, like, you know, CFA textbook, discounted cash flow model, okay, if you earn a lot of your cash flows in the in the far future, which is not by the not true for all tech, right? I mean, meta, for example, gets a lot of cash flow today, it’s not that clear that NVIDIA will be able to maintain this high growth rate. But generally, start that tech stocks like Amazon, with most of the value of Amazon will be realized, you know, 10 years and above, as opposed to, say, an old company that trades for five times cash flow. So theoretically, if you lower the discount rate. The value of these cash flows that are far out in the future is bigger today, so the long duration assets, which include tech stocks in theory, should do better when rates are lower. Now the question is, which rates are we talking about, right? Because what the Fed cut is the overnight rating. Seems to be that if you look at the 10 year yield, the 10 year yield is kind of flattish on the day, right? So you have to look at the 10 year or the 30 year to make that calculation in proper term. The reason I could discover us before I started this is because you could basically we placated narratives. And another narrative that worked quite as well was, Oh, these guys are out of cash, right? Apple famously sits on 200 billion cash. So when the Fed raises rates, they actually make money. I mean, Apple is the money market from these guys as a phone company. So I think the reality is that, Hey, big Tech’s large cap stocks have gone up like crazy for five years now, and then we’ve just tried to justify this with, oh, that’s because of the interest rate channel, or that’s because of the duration channel, but I’m not sure that the two are necessarily related. If anything, I would think that lower rates probably help more small caps, because most small caps have more debt. Some of that debt is more kind of short term oriented. For them to refinance a lower rate probably matters more than for an apple, which is 50 year 50 year debt, and that has more cash and they know what to do with so they know they don’t get, you know, the business is not impacted by what the Fed did today.
Maggie Lake 30:12
That’s a great point, because that was what we talked about when rates were increasing, that it was going to be very difficult for some of those smaller that are much more dependent on that shorter term financing. So of course, it would make sense on the flip so this is my second question, and you touched on it there the Fed cut its overnight Fed funds rate. We all think that immediately impacts the bond market, but if you are seeing the risk that inflation is still bubbling and may increase, and the Fed has now kind of poured more liquidity or gasoline on things. It doesn’t mean that treasuries can’t go up, even though the Fed is cutting rates. Right? They used to call them bond vigilantes, but when the bond market is not happy with inflation, we could see rates go up. We haven’t seen that in a long time. But is that a risk?
Vincent Deluard 31:04
Yeah, so on the on the whole, what was the word that your born, man, your Blackrock guys, the golden era for bones, Golden Age. Or I just
Maggie Lake 31:12
read the headline, I’m not for sure. He did not tell me personally. I just want before you go after Blackrock everybody and get me in trouble, it was a very, very widely publicized head headline
Vincent Deluard 31:23
football. You fixed income? Yeah, fixed income. What’s price, right? I mean, we went from 5% on the 10 year to 3.5 3.6 right? So 1.5% drop in yield. Typically a 10 year has a duration of nine to 10 years. So let’s just stand for simplicity, you had a 15% rally in bonds already. So I would argue, and this is, you know, bonds should be boring, right? You should not expect to make, you know, 15% in bonds in any given year. So I would argue that we already had our golden age for bonds. It was, you know, the past the past six months, for this to continue, you need to make the case that this is these rates are going to keep falling, including where it matters at the long end. So that will get to maybe, you know, 2% on on on the tenure. I mean, I’m not saying it’s impossible. You know, before covid, we had, we had a, you know, we went even below 1% one point. So it’s not impossible, but it’s a balance. Right to me, we are still an economy that is growing at or above potential, with inflation that is still way above the target, with a fed that has missed its target for four years straight, and at the first time of this, inflation is responding with bazooka cuts. So what does that tell you for the term premium? What does that tell you for inflation expectation probably should be higher, so that’s why I’m not a buyer of the golden age for for bonds. We
Maggie Lake 32:53
have another, another chart that you put in your research which talks about the government debt, if we could pull that up. And this is another reason that you’re concerned about the inflation outlook, but some people may also point to it as a reason that the Fed is being aggressive, because the you know the need to pay those interests, make those interest payments, it’s hard to sustain high interest rates when you’ve got spiraling government debt. What do you see happening here? And how do you address people who say, well, it doesn’t matter. Government debt
Vincent Deluard 33:30
doesn’t matter. Well, so I mean, I think what you’re referring to is the idea of fiscal dominance, right? Is, as you raise interest rates, the cost of servicing the debt for the government, especially when you have a highly indebted sovereign, which is our case, right? Basically, with 100% debt to GDP. So let’s say you go from 0% to 5% suddenly you have a 5% of GDP item. That’s, you know, becomes larger than what you spend on defense or entitlement, or even both of them combined. So that’s, that’s an argument that you know the the Fed is basically trying to make life easier for the Treasury by by lowering rates. If that is the case, they will never tell us that.
Maggie Lake 34:10
They will never tell us that, right?
Vincent Deluard 34:15
I will let the viewers come to their own conclusions on this. What I was pointing out about the deficit was, I think, something that people missed before earlier this year is that the deficit was actually shrinking compared to last year. If you, if you compare to last year, we’re running at about 400 billion less.
Maggie Lake 34:34
Is that because of the strong tax collections? Yes, because, again,
Vincent Deluard 34:37
because, in my view, that was because the economy was doing well, so people were paying taxes, but the more people pay taxes, that shrinks the deficit. That means a lower fiscal impulse. So to the extent that we had weakness in economic data this summer, I would attribute it to this kind of weaker fiscal impulse, which you could also see in the job reports. If you look at this bad job report, the one for July, it came from the government. Sector, not so much a private sector. So that was my take, was that we had less of a fiscal impulse in the first half of the year. But this, I was pointing to this deficit in August. We had an operational deficit of three, 50 billion in August. Now, some of that is calendar effects, right? Basically, there was some expenses because, you know, August, the longer month that you know, that that were double counted. So it was not entirely true that the 300 feet, obviously, we are not, you know, annualizing a deficit of $4 trillion that’s that’s not true. But even if so, take that off. Look at things that are recurring. One of them is interest expense. So typically, coupons are paid on the 15th of August, and every every other month like that. We had a 16, 64 billion coupon payment on August 15 last year. It was just 54 so you could see, I think that was what you were pointing to, the impact of kind of higher rates on the deficit. Now, typically, the idea is that, you know, higher rates are restrictive because they force the government to cut on the rest of the budget. That’s what, for example, happens in Europe. So you have a 3% deficit target, interest rates go up. Well, you gotta have to, kind of have to get something else if you’re going to pay more in interest rates, you’re going to have to pay less in in Social Security or in education, something like that and that. What slows the economy now, in the US, we have this very exorbitant privilege of not having to care about the deficit. Effectively, oh, I have to pay more on interest rate. Fine. I’ll just pay more, but I’m not going to cut anything. And effectively, we have not cut anything else. If you look at federal salaries, federal salaries so far this year are 7.6% higher than they were last year, 7.6% it’s nice for you, for government, very, very nice. Social Security benefits is up. Are about 6.5% so again, we have this, this category. Also Medicare spending is about 12% so and these are big, big program. I mean, there’s about, what, 3 million government employees. There’s probably about 70 million people on social security. Medicare is everybody above the age of 65 so this kind of structural growth in spending,
Maggie Lake 37:12
well, this is inflation comes into play, because some of us benchmarked off of inflation and so,
Vincent Deluard 37:19
and some right? I mean, for Social Security, you have a cost of living adjustment for last year was 3.5% and then the the actual benefits paid so far for the year are by 6.5% right. So a lot of that probably has to do with the number of people right. You have all your boomers, right. Your your median Boomer is, you know, probably turning 65 this year, so you are getting to this high birth cohort. So you have more people collecting benefits than people dying. So that’s, that’s part of the story for the for the federal government, I’m not so sure, by the way, because I don’t think we have a big increase in the number of federal government employees. I think this is, might be just, you know, straight up pay increase might have to do with the fact that, you know, there’s an election in in the near month or so,
Maggie Lake 37:58
exactly, trying to hang on to talent, I guess, or or pay them to go campaign. So we have a situation, and again, Jay Powell is going to be talking, so we’re going to watch this. But if you’re, if you’re thinking about your portfolio, you’re right. You’re not day trading this. So it’s okay. That’s the good news, right? You don’t have to respond to the headlines against this backdrop now, and you mentioned, not only did we get the cut Vincent, but it looks like they’re anticipating more cuts in the future right now. This is the because once the Fed goes they usually are begin a series of rates. So this may be the first in what will be more rate, right? So,
Vincent Deluard 38:36
so you can see that from Fed, from futures market. So I’m looking at this screen. I mean, I could even show it here. I don’t know if you can see it. Yeah. Okay, so implied number of cuts for November is 1.4 so that means we basically are where we were before this meeting. You know, when it was split between 25 and 5050, bips. So the market is half, of course, 25 is priced in and about half the market thinks it’s going to be a 50 on in November. I mean, two people, that’s crazy. And then by December, we have three cash price. So basically, what it’s telling us is one, there’s going to they’re going to cut by 25 in the next meeting, and then there’s going to be another, there’s going to be another there’s going to be another 50 somewhere even November or December. Yeah. So, yeah,
Maggie Lake 39:26
very aggressive. This would be a, this would be a Federal Reserve that would be responding to a dramatically slowing economy or some other problem that they see, no doubt. Well, we hope that someone’s telling Jay Powell that before he goes out to that press conference, because this will be one of the things that the Fed tries to massage is,
Vincent Deluard 39:44
I suspect they’re gonna have, they’re gonna try to talk it down a little bit. One good thing, it’s not a good look, right? Then it makes you think that, oh, the economy’s collapsing, which I don’t think is the message they want to convey. I think if I’m the Fed, I’m trying to do this kind of you. You know, mission accomplished, right? Look, inflation has fallen. You know, the Fed funds rate was 5% neutral is 2.7 so I’m just getting to ease, but I’ve actually nailed that soft landing, and the economy is, you know, it’s fine. So if the economy is, as, you know, that narrative that would not justify, you know, if you’re doing adjustment cats, you’re doing something like maybe 9495 or 9798 you just do a couple. You don’t, you know, by 50 bits increment to doing adjustment cats. Adjustment cats are 25 so,
Maggie Lake 40:31
yeah, is this? Is this which, by the way, Vincent just laid that out in much clearer language than you will ever hear from a Fed official. Believe me, you’ll have to, like, have the Google Translator out, because they never say anything that clearly. But do you again, in a backdrop where the economy’s still growing, insurance they’ve cut interest rates, maybe as an insurance policy to help around the margins for those who are feeling the squeeze of borrowing costs, and we have, what’ll be good for stocks may not be disastrous for bonds. What is that sounds like a pretty doable situation, in a situation that’s pretty benevolent for people’s portfolios. What would be the risk that you would say we need to watch out for as we look out the horizon? Because I said we’re not day trading this. So when you roll up and people are having conversations with their financial advisor. What should they be thinking about?
Vincent Deluard 41:24
Well, there’s the reason I’m completely wrong about growth and the economy, which, you know, I would like to be open to that and that the Fed is seeing something lurking behind that I’m completely missing, like some, you know, banking crisis around the corner, and we are, what’s happening here is like, you know, oh, seven, right, when the the Fed get at all time highs. And, you know, 12 months later, stock market had lost 50% of its value when we had, you know, a global recession. Um, that’s a risk. Now, I’m not seeing it, but maybe this something that the Fed sees and I’m not aware of. I mean, we had, you know, the yen rally law. That was not a very good sign, nonprofit rate. I mean, all the classical recession stuff that that’s, I don’t think it’s a high risk, but that’s a risk to me. The bigger risk is, again, the risk that growth is actually reacting already, and that we will get a now we have. I mean, if you think about, you know, what influences growth? First of all, I would like to disclose, just to level set, growth is the natural state of an economy. All else you know, because we are getting smarter over time, we are getting more more efficient. So if you have no your prior for the economy should be that it’s growing. You need, I think people need to make a productive case for recession. But and then what? What influences growth? Well, it’s the stance of monetary policy. Now I would argue that monetary policy was maybe neutral, and now we accommodated. But certainly the stance of monetary policy is easy. We can all agree on that fiscal policy, fiscal policy, we were running a deficit of 6% GDP at full employment now for a couple months, that deficit shrank a little bit because of the timing of the tax receipts. But that’s going to move more a commodity. So easier, easier that. Next one is financial conditions. You know, how our spreads? Is it easy to borrow money? How animal spreads, stocks on all time high junk bond spread are, you know, probably the low in the 5% lowest being so you have very easy financial conditions. Next one is the price of oil commodities. It’s been phoning all summer long. And then the last one would be the dollar, and the dollar has weakened and is weakening some more because of what the Fed does. So what’s likely going to happen is growth going to decelerate, or is it going to accelerate? I see a lot more in Yeah. Those
Maggie Lake 43:38
are all programs.
Vincent Deluard 43:40
These are all growth positive. All growth positive. So real growth of 3% in the past four quarters, so yeah, for growth in the economy that’s already going above potential.
Maggie Lake 43:53
So So you’re leaving open the idea that maybe you’re wrong on growth, but for all the reasons that you just said you’re you’re feeling like that’s not so what’s the other risk that that so if, because, if you’re thinking about, what do I need to hedge against, right? That’s always what the what the real conversation is, Where can I get my gains right? What do I need to hedge against if something goes wrong? So maybe a recession. But what’s the flip side? What’s the other thing that that would be the concern, I guess, inflation, right? Yeah, yeah,
Vincent Deluard 44:23
it’s a reaction of inflation, and the Fed has to pivot the pivot, right? We’re joking about that. But maybe I would call that probably today is going to be remembered as a as a reverse Trichet. So Trichet was the famous French central bank of the of the European Central Bank that hiked rates in 2008 just as the economy entered the global session, and then he did that again in 2011 just as we had the Eurozone. So twice height rate. And then the following meeting had to cut it. Now it may not be that immediate. I don’t expect them to hike back in November, but in six months, yeah, there’s a good chance of that. Now, how do I how do you hike here that I’m. You can take a position on rates future or options on a higher Fed funds rate in six months. I mean, that’s probably really, really cheap right now, because everybody’s pricing more cuts. You can do that with, you know, commodities, gold, obviously. I mean, if we have this, if this is just a new normal, and the theory you hinted at with, oh, maybe the Fed is just helping the Treasury finance deficit. If that’s the case, then you you know you don’t own enough gold,
Maggie Lake 45:31
exactly. Well, it seems these days, all conversations lead back to gold, and there’s a reason, Vincent, I know that you’re anxious to go check in, and we all are to see what Jay Powell is saying and what it might mean. But thank you so much for helping us understand the circumstances and really like zero in on the things that we should be pushing back on a little bit, or at least really investigating this tension between growth and inflation. They can’t both be right, right? Like if you think there’s going to be recession, then what does that mean? If you think there’s not, you feel like the economy is going well, then you then you’ve got something else to worry about, that’s inflation, and you should be thinking about both those things when it comes to your portfolio. So I think that positions everyone really well to listen to the conversation from the Federal Reserve. It seems like this is a very we have an election which we didn’t even get into. It seems like this is not a period where people can be very complacent about what’s happening. Do you expect volatility through the fall? It seems like that’s coming up a lot. Do I expect what? Sorry, volatility through the Yeah, um,
Vincent Deluard 46:39
I mean, we might see it in the press conference. I mean, everything we talked about in terms of market reaction might be undone because of one bad word that power may say in the press conference. And I actually suspect some of that is going to happen, because typically the Fed likes to, you know, give with one hand and take back with the other hand. So if we have a very dovish statement, then maybe we’ll have a bit of a more hawkish press conference. So, yeah, I mean, I, I would also say you can go crazy trying to day trade that stuff. Maybe, you know, I mean, if you want to have fun and then, you know, and give commissions to your broker. By all means, go for it. But maybe the main message we should get again is, hey, the Fed is cutting by 50 basis point when real growth is at 3% inflation is way above target. And again, they only hide by 25 bits when inflation is at 8% what does that tell you about their reaction function. What does that tell you about the kind of target that they have? Are we sitting in 2% world or not? And to me, everything points to the idea that we are no longer in a 2% inflation world, that that inflation target is at best, a floor, a floor that I think we won’t even touch, and that we are in this kind of structurally high inflation, higher rate, higher growth environment, because we have, yeah, policy that is, you know, adding stimulus on top of stimulus, fantastic.
Maggie Lake 48:11
I love your your research and your thinking. It’s always outside the box or super original thinker. And I think we needed this at a time when we are going to have to make our way through this volatility and are facing a pivot now from the Fed and all that brings with it. So thank you so much. Appreciate it. Vincent,
Unknown Speaker 48:27
Thanks Maggie, and
Maggie Lake 48:28
thanks to all of you for watching. We’ll see you again next time. Had
Andrew Brill 48:31
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